Holiday Pay on Termination: Payment in Lieu Calculation

When employment ends, you must settle up holiday entitlement. Employees get paid for untaken accrued leave, or you may need to deduct for overdrawn holiday. Get this wrong and you risk tribunal claims for unlawful deductions.

The Legal Requirement

Working Time Regulations 1998 state that workers must receive payment in lieu of accrued but untaken statutory holiday (5.6 weeks) when employment ends.

This applies to:

• Resignation
• Dismissal
• Redundancy
• End of fixed-term contract
• Retirement
• Any other termination

You cannot: Refuse to pay accrued holiday on termination.

Basic Calculation

Formula

(Annual entitlement ÷ 12) × Months worked = Accrued holiday

Then:

Accrued holiday - Holiday taken = Holiday owing

Multiply by daily/weekly rate to get payment due.

Example: Employee Owed Holiday

Scenario:

• Full-time employee (28 days entitlement)
• Holiday year: 1 Jan - 31 Dec
• Leaves: 31 May (5 months worked)
• Taken: 8 days

Calculation:

(28 ÷ 12) × 5 = 11.67 days accrued
11.67 - 8 = 3.67 days owed

Payment: If weekly pay is £500:

(£500 ÷ 5) × 3.67 = £367 to be paid

Example: Employee Overdrawn

Scenario:

• Full-time employee (28 days entitlement)
• Leaves: 30 April (4 months worked)
• Taken: 12 days

Calculation:

(28 ÷ 12) × 4 = 9.33 days accrued
9.33 - 12 = -2.67 days (overdrawn)

Deduction: If weekly pay is £500:

(£500 ÷ 5) × 2.67 = £267 to be deducted

But: You can only deduct if your contract allows it.

Months Worked Calculation

What Counts as a Month?

Most employers use calendar months.

Example: Start: 15 February End: 14 September

Months worked:

• Feb (part): 0.5 month
• March-August: 6 months
• Sept (part): 0.5 month
• Total: 7 months

Precise Daily Calculation

For greater precision, calculate accrual daily:

(Annual entitlement ÷ 365) × Days worked = Accrued holiday

Example: 28-day entitlement, worked 127 days:

(28 ÷ 365) × 127 = 9.75 days accrued

Part-Time Employees

Pro-Rata Entitlement

First, calculate pro-rated annual entitlement:

(Days worked per week ÷ 5) × 28 = Annual entitlement

Then apply the termination formula.

Example

Scenario:

• Works 3 days/week
• Annual entitlement: (3 ÷ 5) × 28 = 16.8 days
• Leaves after 6 months
• Taken: 4 days

Calculation:

(16.8 ÷ 12) × 6 = 8.4 days accrued
8.4 - 4 = 4.4 days owed

Irregular Hours Workers (12.07%)

Accrual Calculation

For irregular hours workers who accrue holiday as 12.07% of hours worked:

Step 1: Total hours worked since start of holiday year.

Step 2: Calculate hours accrued:

Hours worked × 12.07% = Holiday hours accrued

Step 3: Check how many holiday hours were taken.

Step 4: Calculate payment for remaining hours:

(Holiday hours accrued - Holiday hours taken) × Average hourly rate

Example

Scenario:

• Zero-hours worker
• Worked 580 hours since Jan
• Took 40 hours holiday
• Average hourly rate: £15/hour

Calculation:

580 × 12.07% = 70 hours accrued
70 - 40 = 30 hours owed
30 × £15 = £450 payment

What Rate to Pay Holiday At

First 4 Weeks of Statutory Leave

Must be paid at the full rate, including:

• Basic pay
• Regular overtime
• Commission
• Shift allowances
• Any other regular earnings

Use the 52-week average calculation method.

Additional 1.6 Weeks Statutory Leave

Can be paid at basic rate only, unless contract says otherwise.

Contractual Leave Above Statutory

Whatever the contract states (often basic rate).

Practical Approach

Many employers pay all holiday at the full rate (52-week average) to simplify and avoid disputes.

Calculating the Payment Rate

Fixed Hours, Fixed Pay

Simple: Pay at their normal daily/weekly rate.

Example: £30,000 salary = £2,500/month = £576.92/week

For 3.5 days owed:

(£576.92 ÷ 5) × 3.5 = £403.84

Variable Earnings

Use the 52-week average method (or however many weeks they worked if fewer than 52).

Example:

• Total earnings over employment: £15,600 (40 weeks worked)
• Average weekly pay: £15,600 ÷ 40 = £390/week
• Owed 2 weeks' holiday
• Payment: 2 × £390 = £780

Commission Workers

Include commission in the 52-week average.

Example:

• Basic: £25,000/year (£480.77/week)
• Average commission: £200/week
• Total average: £680.77/week
• Owed 1.5 weeks' holiday
• Payment: 1.5 × £680.77 = £1,021.16

Overdrawn Holiday: Can You Deduct?

Contract Must Allow It

You can only deduct pay for overdrawn holiday if:

• Your employment contract contains a clear clause allowing it
• The deduction doesn't take pay below National Minimum Wage

Example Contract Clause

"If employment terminates and the employee has taken more holiday than they have accrued, the employer may deduct from final pay an amount equal to the excess holiday taken."

Without a Contract Clause

You cannot deduct.

You may be able to ask the employee to repay voluntarily, but you cannot withhold final pay without their consent.

Partial Months

Be careful with calculations. If someone leaves mid-month, ensure you calculate accrual precisely to avoid incorrectly claiming holiday is overdrawn.

During Notice Period

Accrual Continues

Holiday continues accruing during the notice period, whether:

• Working notice
• Garden leave

Taking Holiday During Notice

Employees can request to take holiday during notice. You can:

• Agree: Pay holiday as normal, add any remaining accrued holiday to final pay
• Refuse: Employee works notice, you pay all accrued holiday at termination

Mandating Holiday During Notice

You can require employees to take holiday during notice if you give proper notice (usually double the holiday length).

Example: "I require you to take 5 days' holiday during your notice period. You'll take this on [dates]."

Give notice at least 10 days before the required holiday.

Garden Leave and Holiday

What Is Garden Leave?

Paying an employee not to work during notice (usually to keep them away from clients/data).

Holiday accrues during garden leave as normal.

Payment at End

Pay for all accrued but untaken holiday at the end of the garden leave period.

Different Holiday Year Scenarios

Holiday Year Matches Calendar Year

Calculation is straightforward (January-December).

Holiday Year Matches Tax Year

April-April. Same calculation principle.

Rolling Holiday Year (Anniversary of Start Date)

Example:

• Employee started 1 March
• Holiday year: 1 March - 28 Feb
• Leaves: 30 November

Months in current holiday year: March-November = 9 months

Calculate accrual based on 9 months.

Mid-Holiday-Year Termination

Always calculate from the start of the current holiday year to termination date, not from start of employment.

Statutory vs Contractual Leave

5.6 Weeks Statutory

Must be paid on termination. No contractual clause can remove this.

Additional Contractual Leave

If your contract gives more than 5.6 weeks (e.g., 30 days total), the additional leave may be subject to different rules:

• Contract may allow "use it or lose it"
• May not have to pay for excess contractual leave on termination (if contract says so)

Check your contract carefully.

Practical Approach

Most employers pay for all accrued holiday (statutory + contractual) on termination to avoid disputes.

Bank Holidays

If Bank Holidays Are Separate

Some contracts give "28 days plus bank holidays."

On termination: Calculate accrual for the 28 days, plus check if any bank holidays fell during the employment period that weren't taken.

If Bank Holidays Are Included

Most common: 28 days inclusive of bank holidays (20 + 8).

On termination: Calculate accrual as normal (no separate bank holiday calculation).

Payment Timing

Must Be Paid in Final Pay

Holiday payment in lieu must be included in the employee's final pay.

Don't delay paying accrued holiday beyond the normal final pay date.

PAYE and National Insurance

Holiday pay in lieu is subject to:

• PAYE tax
• National Insurance contributions
• Pension contributions (if within normal pay rules)

Treat it as normal pay for tax purposes.

Redundancy and Holiday Pay

Separate Payments

Redundancy pay and holiday pay are separate.

Both are due:

• Statutory redundancy payment (if eligible)
• Payment for accrued untaken holiday

Don't Confuse the Two

Redundancy pay has its own calculation. Holiday pay is based on accrual as normal.

Timing

Pay both in the final pay or redundancy payment.

Dismissal and Holiday Pay

Summary Dismissal (Gross Misconduct)

Even if dismissed for gross misconduct (no notice, no notice pay), you still must pay accrued untaken holiday.

Holiday pay is not discretionary.

Dismissal with Notice

Calculate accrual up to the end of notice period (whether worked or paid in lieu).

Death of an Employee

Holiday Pay Due to Estate

If an employee dies, accrued untaken holiday pay should be paid to their estate.

Calculate as normal up to the date of death.

Record Keeping

What to Document

For each leaver:

• Holiday year start and end dates
• Annual entitlement
• Days/hours accrued
• Days/hours taken
• Calculation of owing/overdrawn amount
• Payment or deduction made

Keep for at least 3 years (or longer for tribunal protection).

Common Mistakes

Mistake 1: Not Paying Accrued Holiday

Issue: Forgetting to include holiday pay in final pay.

Result: Unlawful deduction from wages. Tribunal claim possible for up to 2 years back pay.

Mistake 2: Wrong Accrual Calculation

Issue: Calculating from start of employment rather than start of current holiday year.

Result: Overpaying or underpaying.

Mistake 3: Deducting Overdrawn Holiday Without Contract Term

Issue: Deducting pay for excess holiday taken when contract doesn't allow it.

Result: Unlawful deduction. Employee can claim back.

Mistake 4: Paying at Basic Rate Only

Issue: Paying holiday at basic rate when employee has variable earnings (overtime/commission).

Result: Underpayment. Tribunal claim possible.

Mistake 5: Refusing to Pay on Gross Misconduct Dismissal

Issue: Thinking gross misconduct means no holiday pay due.

Result: Unlawful. Holiday pay is always due.

Mistake 6: Confusing Statutory and Contractual Leave

Issue: Applying "use it or lose it" rules to statutory 5.6 weeks on termination.

Result: Unlawful non-payment.

Disputes Over Holiday Pay at Termination

Common Disputes

• Employee claims accrued more than you calculated
• Employee claims overdrawn deduction was unlawful
• Rate of pay disputed (basic vs full earnings)

Avoiding Disputes

1. Clear records: Show full calculations
2. Communicate early: Explain accrual in advance
3. Pay the full rate: Avoid arguments about what should be included
4. Check contract: Ensure deduction clauses exist before deducting

If an Employee Challenges

Provide:

• Holiday year dates
• Entitlement calculation
• Days taken record
• Accrual calculation
• Payment rate calculation

If still disputed, they may claim at tribunal.

Tribunal Claims

Unlawful Deduction from Wages

Failing to pay accrued holiday is an unlawful deduction.

Time limit: Claims can go back 2 years from termination date.

Remedy: Tribunal orders payment plus interest.

Avoiding Claims

• Calculate accrual accurately
• Pay at the correct rate (52-week average for variable pay)
• Include in final pay on time
• Keep clear records

Practical Tips

Tip 1: Automate Calculations

Use payroll software that tracks holiday accrual and calculates payment in lieu automatically.

Tip 2: Leaver Checklist

Create a checklist for all leavers:

• Calculate holiday accrued
• Check holiday taken
• Calculate owing/overdrawn
• Determine payment rate
• Process in final pay
• Document calculation

Tip 3: Early Communication

When someone resigns, review their holiday position early:

• Can they take remaining holiday during notice?
• Will they be paid for untaken leave?
• Are they overdrawn (if so, check contract)?

Tip 4: Clear Payslips

On the final payslip, show holiday pay separately:

• "Holiday pay in lieu: £XXX"
• Makes it clear it's been paid

Tip 5: Contract Review

Ensure your employment contracts have:

• Clear holiday year definition
• Overdrawn holiday deduction clause
• Holiday accrual explanation

Example Final Pay Calculation

Scenario:

• Employee: Sarah
• Salary: £35,000/year (£673.08/week)
• Holiday entitlement: 28 days
• Holiday year: 1 Jan - 31 Dec
• Termination: 31 August (8 months worked)
• Holiday taken: 12 days

Step 1: Calculate accrual

(28 ÷ 12) × 8 = 18.67 days accrued

Step 2: Holiday owing

18.67 - 12 = 6.67 days owed

Step 3: Calculate payment

(£673.08 ÷ 5) × 6.67 = £898.20

Step 4: Include in final pay

• Normal salary for August: £2,916.67
• Holiday pay in lieu: £898.20
• Total (before tax): £3,814.87

Deduct PAYE, NI, pension as normal.

Key Takeaways

• Always pay accrued untaken statutory holiday (5.6 weeks) on termination
• Calculate precisely: From start of holiday year to termination date
• Pay at the correct rate: 52-week average for variable pay
• Check contract before deducting for overdrawn holiday
• Include in final pay: Don't delay payment
• Keep clear records: To defend against disputes

Getting this right avoids tribunal claims and treats departing employees fairly.